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Top 10 Municipal Bond ETFs

This listing includes some, not all, of the many municipal bond ETFs that have proliferated over the past few years as issuers have discovered a reasonable way to price related indexes. After all, since bonds are a "dealer market" vs a listed securities market where valuations are transparent, pricing bonds has always been in the eye of the various bidders. A reasonable summary of this difficulty was published by Dan Seymour of the Bond Buyer in January 2011:

"The muni market includes more than 60,000 issuers and at least 1.2 million CUSIP numbers. Munis are considered less liquid than Treasury or corporate bonds. Some muni bonds never trade, and most trade infrequently. Indexes designed to reflect values in the municipal bond market rely on pricing services, such as Interactive Data, to evaluate bonds that aren't trading.

Investors don't necessarily always believe these pricing services. It might be that a bond that would otherwise be trading at a lower price is quoted by a pricing service at a higher price simply because nobody is trading it, so there's no discovery of the lower price.

That explains why municipal yield-curve scales such as Municipal Market Data and Municipal Market Advisors can often disagree on where yield levels are -- they are often extrapolating based on general conditions, rather than visible trades."

Due to some late 2010 panic among investors ETFs disconnected from their indexes as selling overwhelmed index structure creating large discounts to NAV for investors. This is why MUNI ETF returns were high during 2011 as the rebound occurred early in the year and no doubt exaggerated returns. And no yields are low but not necessarily lower than taxable yields for the same maturity. I remember complaining to my boss in 1976 when yields suddenly dropped to 5% briefly for high grade general obligation bonds. He calmly said: "They'll buy 'em when they're 3% because they hate taxes always." He was right.

As a former bond dealer myself with a Municipal Principal Series 53 license, I can attest on these difficulties. You may think these problems are isolated and they can be but remember the difficulty encountered by muni-bond funds one year ago when most funds were not tracking the indexes well at all. This was occasioned by investor flight given worries over municipal budgetary and fiscal soundness issues. (These problems are well-outlined in the linked article above.) But these issues can be geographic in nature as well. In 1975 the U.S. northeast was plagued by the contagion from NY City's financial crisis. Suddenly Massachusetts, Pennsylvania and other municipalities in the region had to pay large premiums given their proximity to New York. California had its problems with tax reform later and Washington Public Power went bankrupt. In 1929 nearly 70% of all municipal bonds with investment grades went bankrupt so don't be too sanguine about conditions.

The latest rage in muni-land which has always had the reputation as a gimmicky market is Build America Bonds (BABS). Investors should know these bonds are federally taxable but exempt from state and local taxes for investors from that jurisdiction. Institutions such as casualty insurance companies have been feasting on these issues and this is expected to continue.

We rank the top 10 ETF by our proprietary stars system as outlined below. However, given that we're sorting these by both short and intermediate issues we have split the rankings as we move from one classification to another so rankings aren't necessarily in order.

Established linked index even if "enhanced" Good performance or more volatile if "enhanced" index Average to higher fee structure Good portfolio suitability or more active management if "enhanced" index Decent liquidity

Enhanced or seasoned index Less consistent performance and more volatile Fees higher than average Portfolio suitability would need more active trading Average to below average liquidity

Index is new Issue is new and needs seasoning Fees are high Portfolio suitability also needs seasoning Liquidity below average

We feature a technical view of conditions from monthly chart views. Simplistically, we recommend longer-term investors stay on the right side of the 12 month simple moving average. When prices are above the moving average, stay long, and when below remain in cash or short. Some more interested in a fundamental approach may not care so much about technical issues preferring instead to buy when prices are perceived as low and sell for other reasons when high; but, this is not our approach.

SHM follows the Barclays Capital Managed Money Municipal Short Term Index which is a rules-based, market-value weighted index comprised of publicly traded municipal bonds that cover the U.S. dollar denominated short term tax exempt bond market, including state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds.

The fund was launched in October 2007. The expense ratio is .20%. AUM equal $1.5 billion and average daily trading volume is 338K shares. As of late January 2012 the annual dividend yield was 1.43% and YTD return was .37%. The one year return was 5.69%.

SUB follows the index of the same name. The fund was launched on November 2008. The expense ratio is .25%. AUM equal $485 million and average daily trading volume is 30K shares. As of late January 2012 the annual yield was 1.28% and YTD return was -.18%. The one year return was 4.17%.

AMT taxes are a significant issue for many people who are trapped in this category with some not realizing it before it's too late.

One thing I was taught decades ago was to always look at the underlying rating versus the insured rating. It became a little too common here with the advent of municipal bond mutual funds to insure "everything" like S&P did with mortgages--just an advisory.) The fund was launched in October 2007. The expense ratio is .28%. AUM equal $623 million and average daily trading is 153K shares. As of late January 2012 the annual dividend yield was 4.49% and YTD return was 2%. The one year return was 19.43%.

TFI follows the Barclays Capital Municipal Managed Money Index is a rules-based, market-value weighted index engineered for the tax exempt bond market. All bonds in the National Municipal Bond Index must be rated Aa3/AA- or higher by at least two of the following statistical ratings agencies: Moody's, S&P and Fitch. The fund was launched in September 2007. The expense ratio is .20%.

AUM equal $1 billion and average daily trading volume is 250K shares. As of late January 2012 the annual dividend yield was 3.47% and YTD return was 1.39%. The one year return was 17.89%.

MUNI is an actively managed designed to be appropriate for investors seeking tax-exempt income. The fund consists of a diversified portfolio of primarily intermediate duration of high quality bonds.

The fund was launched in November 2009. The expense ratio is .35%. AUM equal $115 million and average daily trading volume is 25K shares. As of late January 2012 the annual dividend is 2.19% and YTD return is .55%. The one year return is 9.34%.

MLN follows the Barclays Capital AMT-Free Continuous Municipal Index which provides broad exposure to investment-grade municipal bonds with a nominal maturity of 17 years or more. The fund was launched in January 2008. The expense ratio is .24%. AUM equal $73 million and average daily trading volume is 51K shares. As of late January 2012 the annual dividend yield was 4.34% and YTD return 1.79%. The one year return was 24.97%.

BAB tracks the BofA Merrill Lynch Build America Bond Index which is part of stimulus program launched by the Obama administration. These bonds are hybrid securities and have the unique position of being taxable under the guidelines linked HERE.

BAB's securities are 35% underwritten by the Federal government as to interest payments. These bonds have been extremely popular with institutional investors, particularly insurance companies. The fund was launched in 2009. The expense ratio is .35%. AUM equal $800M while average daily trading volume is 200K shares. As of late January 2012 the annual dividend yield was 5.19% and YTD return .31%. The one return was 21.55%.

The expense ratio is .35%. AUM equal $376 million with average daily trading volume in excess of 145K shares. As of late January 2012 the annual dividend yield was 5.71% and YTD return 2.79%. The one year return was 18.23%.

Data as of First Quarter 2012

HYD Top Ten Holdings & Weightings

Texas Private Activity Bd Surf Sr Lie 7%: 2.48%

New Jersey Econ Dev Auth 6.625%: 2.31%

Illinois Fin Auth 5.5%: 2.23%

Illinois Fin Auth 6%: 1.46%

Indiana Fin Auth 5.5%: 1.43%

De Kalb Cnty Ga Hosp Auth 6.125%: 1.43%

Montana St Brd Invt Res R Res 7%: 1.43%

Red River Auth 6.7%: 1.36%

Greater Orlando Aviation Auth 6.5%: 1.35%

South Carolina Jobs-Economic D Hos 5.25%: 1.34%

Municipal bonds are under increasing pressure to avoid default threats articulated by some pundits as likely given weak tax receipts particularly with smaller municipalities and revenue bond structures. General obligation bonds require the issuer to raise taxes and/or cut spending to meet interest and principal payments as holders stand first in line ahead of salaries to bureaucrats and civil servants.

We do see some consistent overbought conditions which shouldn't be ignored completely. Nevertheless strong trends like this can overpower any sound technical strategies including long-term DeMark indicators.

As stated with other sectors, remember ETF sponsors must issue and their interests aren't aligned with yours. They have a business interest and wish to have a competitive presence in any popular sector.

As stated with other sectors, remember ETF sponsors must issue and their interests aren't aligned with yours. They have a business interest and wish to have a competitive presence in any popular sector.

For further information about portfolio structures using technical indicators like DeMark and other indicators, take a free 14-day trial at ETF Digest. Follow us on Twitter and Facebook as well and join our group conversations.

(Source for data is from ETF sponsors and various ETF data providers.)

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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